## _wp1055

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### Introduction and objectives
- Examines channels through which FX swap transactions could:
  - affect a country’s financial stability; and
  - impact economic stability.
- From a financial stability perspective, the paper:
  - shows how regulatory requirements under the Basel Accords affect the charge of banks holding FX swaps for funding and/or hedging purposes;
  - demonstrates how use of FX swaps by banks could have important implications for their liquidity positions, especially during periods of significant market volatility; and
  - discusses how recent accounting rules have improved the disclosure of FX swaps on banks’ balance sheets.
- From an economic stability perspective, the paper:
  - considers how dislocations in the FX swap market could increase the costs of funding and hedging for banks, with consequences for their lending activity and a country’s balance of payments;
  - discusses how FX swap transactions could cause significant exchange rate volatility during periods of market turmoil, with potential implications for economic activity; and
  - presents strategies that central banks could employ in mitigating pressures in the FX swap market.
- Structural note:
  - Background and key features of FX swaps are in Section II.
  - Channels affecting financial stability are in Section III.
  - Macro-economic implications are in Section IV.
  - Central bank mitigation strategies are in Section V.
  - Technical information and detailed applications are presented in the appendices.

### Stylized facts and market developments
- Definition and uses:
  - An FX swap is an agreement to exchange one currency for another at predetermined times, representing borrowing and lending of currencies on a collateralized basis; used for managing liquidity, shifting delivery dates, hedging FX positions, speculation, and taking positions on interest rates.
- Growth and turnover (pre-crisis trends):
  - Average daily turnover in traditional global FX markets expanded by 69 percent to $3.2 trillion over April 2004 to April 2007.
  - FX swaps average daily turnover rose by 80 percent (versus 45 percent in the preceding three-year period).
  - Cross-border turnover in FX swaps increased by 78 percent to $1.1 trillion between April 2004 and April 2007.
  - Share of FX swap transactions with maturity of less than seven days increased to 78 percent from 73 percent.
  - Cross-border transactions represented more than 60 percent of total FX swaps turnover in April 2007.
- Crisis-era contractions and volatility:
  - Notional amounts outstanding in forwards and FX swaps fell by 33 percent from the first-half of 2008, followed by an uptick of 9 percent in 2009 H1.
  - Forwards and FX swaps gross market values doubled to $1.6 trillion in 2008 H2, then almost halved to $870 billion in 2009 H1.
  - Positions in FX derivatives declined sharply in 2008 H2 among G-10 and Switzerland.
- Market scale and concentration:
  - FX transactions are estimated at around $4 trillion daily, with the top 10 currency traders accounting for nearly 80 percent of the total volume.

### Financial-stability channels and regulatory framework
- Risks and mechanics:
  - FX activities can cause rapid large losses for banks, particularly under increased exchange-rate volatility.
  - Disruptions in the FX swap market can threaten banks’ solvency and liquidity and thereby the stability of the banking system.
- International standards and mitigation:
  - Basel Accords (Basel I and Basel II) applied to capture risks posed by FX instruments.
  - Under Basel, credit exposure for derivatives equals current net replacement value (NRV) plus an add-on capturing future exposure; counterparty risk weights applied to derive the credit risk charge.
  - Pillar I market risk: capital charge of 8 percent of overall net open FX positions.
  - International Financial Reporting Standards (IFRS, IAS 39) require fair-value recognition of derivatives, improving disclosure.
  - ISDA Master Agreement and Credit Support Annex provisions mitigate credit risk via collateral posting and discounting of non-cash collateral.
- Liquidity risk and margining:
  - Marking-to-market under ISDA agreements can trigger frequent collateral payments; variations in fair value of an FX swap can drain liquidity in volatile conditions.
  - Margin calls may be triggered by exchange rate movements, and persistent weakening of the domestic currency can lead to sustained outflows of liquidity, potentially producing solvency problems if a bank cannot meet short-term cash flow obligations.

### Market dynamics observed during the recent crisis
- Initial trigger and propagation:
  - Turbulence intensified in late 2008, initially caused by a shortage of U.S. dollar funding among non-U.S. financial institutions.
  - Non-U.S. institutions sought U.S. dollars via FX swaps while traditional suppliers hoarded liquidity and withheld lending due to counterparty risk, making the market one-sided.
  - Institutions with euro and Swiss franc liabilities also faced similar funding difficulties as the crisis evolved.
- Consequences:
  - One-sided order flow concentrated on U.S. dollar borrowing led to deviations from covered interest parity for the euro, sterling and yen versus the U.S. dollar.
  - The U.S. dollar basis spread (premium paid by international institutions to obtain dollars in the FX swap market) became persistently large and positive during the crisis.
  - Hedging activity and speculative use of FX swaps increased volatility in FX spot markets for numerous currencies.
- Systemic implications:
  - Stress in FX swap markets raised concerns about banks’ ability to roll over funding, potentially constraining credit supply to local economies and affecting balance-of-payments financing.
  - The crisis highlighted the role of central banks in FX swap markets.

### Central bank role and policy responses
- Central bank operations and objectives:
  - FX swap facilities used to control system liquidity, manage international reserves, and smooth disorderly exchange rate fluctuations.
  - Policy options in response to FX funding shortages and exchange rate pressure:
    - Raise interest rates to attract investors.
    - Intervene via outright sales of foreign reserves.
    - Use foreign exchange reserves for FX swap operations with market counterparties.
- Balance sheet mechanics and implications (Box 5 example):
  - Example operation parameters:
    - Central bank provides FX100 million, equivalent to DC105 million at current spot rate.
    - Priced at 5 forward basis points (or 500 pips) premium, forward rate DC1.10 per unit of FX.
    - At start: central bank provides FX100 million and absorbs DC105 million.
    - On maturity: central bank removes FX100 million and injects DC110 million back into the market.
  - Accounting and risks:
    - FX swaps create contingent assets and liabilities; typically off-balance sheet initially and subsequently recorded as receipts/payments occur.
    - Covered nature means central banks normally do not assume underlying FX risk; drawdown could be permanent if the swap counterparty defaults.
  - Crisis usage and coordination:
    - Swap lines between central banks were established to backstop limited liquid reserves in shortage currencies.
    - Major central banks coordinated swap line actions to augment liquid euro and U.S. dollar assets of receiving central banks in December 2007 and at various points in 2008.

### Box 1 — Key features of FX swaps (mechanics, pricing, uses)
- Mechanics and conventions:
  - FX swap: OTC instrument with two legs (near/spot value date and far date), single exchange and re-exchange.
  - “Short-dated swap” if both value dates are less than one month; “forward swap” if one or both value dates are one month or more.
  - Most second legs occur within a week; standard maturities commonly one week, one month, three months; odd/broken dates also traded.
- Pricing and swap points:
  - Cost determined by the interest rate differential; covered interest parity arbitrages the cost to equal the FX value of the interest differential.
  - Swap points measure the cost; when DC r rises, swap points for borrowing domestic currency increases.
  - At inception, present value of the FX swap contract is zero (excluding transaction cost).
- Distinctions:
  - FX swaps vs interest rate swaps (stream of interest payments in same currency) vs currency swaps (exchange of principal and interest streams).

### Box 2 / Margining — mechanics and consequences
- OTC bilateral nature creates counterparty risk; centrally cleared markets mitigate via clearinghouse, initial collateral and maintenance margin.
- Margin thresholds:
  - Mutually agreed, typically based on credit ratings; margin calls occur when exposure exceeds threshold.
  - Swap exposures cannot be netted across counterparties (netting within same counterparty possible), limiting offsetting of margin calls and tying up working capital.
- Illustration (Appendix VI example):
  - Contract at t0: bank provides DC105 for FX100; maturity t12: bank repays FX100 and receives DC110.
  - Margin thresholds: bank DC5 million; counterparty FX7 million.
  - Key dated movements and margin consequences (selected):
    - At t2 swap rate DC1.00: counterparty out-of-the-money exceeds FX7 million threshold by FX3 million → margin call FX3 million.
    - At t3 swap rate DC0.98: counterparty out-of-the-money exceeds FX7 million threshold by total FX5.2 million → additional margin call FX2.2 million.
    - At t6 swap rate DC1.15: bank out-of-the-money by DC5 million (equal to bank’s DC5 million threshold) → no margin call.
    - At t7 swap rate DC1.19: bank out-of-the-money by DC9 million, DC4 million above threshold → counterparty calls DC4 million.
    - At t8 swap rate DC1.25: bank out-of-the-money by DC15 million → additional margin call DC11 million.
    - At t12 maturity swap rate DC1.45: bank out-of-the-money by DC35 million; margin calls totaling DC30 million (DC35 million less margin threshold DC5 million) would have been paid.
  - Total margin called reported in the table: 30 (DC).

### Box 3 — Pricing of an FX swap and basis spread
- Pricing concept:
  - No-arbitrage condition: investing in domestic cash vs converting via FX swap and investing abroad must yield equal returns.
  - U.S. dollar “basis spread” on another currency = Implied FX swap U.S. dollar interest rate – benchmark U.S. dollar interest rate (example: implied USD interest rate from USD/EUR 3-month FX swaps minus U.S. dollar LIBOR).
- Empirical behavior:
  - In normal times, U.S. dollar basis spread around zero for major liquid currencies.
  - During the global financial crisis, FX swap-implied U.S. dollar funding rates significantly exceeded dollar-denominated interest rates when demand for dollars far outstripped supply.

### Channels from FX swap market dislocations to external financing gaps and exchange-rate effects
- Mechanisms creating a BoP external financing gap:
  - Shortening of maturities front-loads rollover requirements; combined with higher FX swap costs increases external financing needs and may force closure of FX swap positions, creating spot FX demand and pressure on the domestic currency.
  - Foreign counterparties cutting exposures reduces external financing available to the country.
  - Margin calls on FX swap contracts with foreign counterparties generate financial account outflows; aggregate outflows can be substantial when exchange rate depreciation affects many domestic institutions simultaneously.
- Macroeconomic consequences of closing an external financing gap:
  - Pressure on the exchange rate or central bank international reserves (depending on exchange rate regime).
  - Squeeze in FX liquidity in the domestic economy, affecting trade and other economic activity.
- Hedging and speculative scenarios that can affect the spot exchange rate (three scenarios summarized):
  - Scenario 1 — Bank closing a net open FX position: spot sales of FX initially strengthen domestic currency; at maturity reversing transactions can weaken it.
  - Scenario 2 — Foreign investor holding local securities: spot sales of domestic currency for FX can weaken domestic currency; subsequent swaps upon sale of securities affect flows.
  - Scenario 3 — Speculator: swaps to borrow domestic currency and sell it in spot can weaken domestic currency; speculators may later purchase domestic currency at depreciated levels to close positions.

### Appendices and data summaries
- Appendix I — Developments in Global FX Swap Activity (highlights):
  - By April 2007:
    - United Kingdom average daily turnover almost $900 billion.
    - United States almost $240 billion daily.
    - Slovenia average daily turnover $60 million.
  - Turnover among emerging markets varied from $32 million in Brazil to $15 billion in Russia.
  - Share of emerging market currencies in FX activity rose to almost 20 percent in 2007 from about 15 percent in 2004.
  - Outstanding notional amounts in forwards and FX swaps increased by 78 percent over 2004–07 (compared to 26 percent in preceding 3-year period).
  - Notional positions of non-financial customers more than doubled during 2004–07.
  - Notional amounts outstanding in forwards and FX swaps fell by 33 percent in H2 2008 among G-10 and Switzerland, followed by a 9 percent uptick in H1 2009.
  - Average daily volume in FX swaps at U.S.-based participants fell by 27 percent in April 2009 compared to a year earlier; activity with non-financial customers fell by almost 58 percent over April 2008–09.
  - In the United Kingdom, turnover in FX swaps fell by almost 29 percent during April 2008 to April 2009; activity with non-financial institutions fell by 41 percent.
  - Market concentration in OTC FX derivatives increased over time; Herfindahl index increases more pronounced in forwards, FX swaps and currency swaps than options.
- Appendix material includes:
  - How FX swaps affect the capital adequacy ratio (Appendix II);
  - Calculation of the credit risk charge for FX swaps (Appendix III);
  - Assumptions of FX spot and swap rates (Appendix IV);
  - Closing a net open FX position using FX swaps (Appendix V);
  - An illustration of how margin calls on FX swaps are calculated (Appendix VI);
  - Recording of FX swaps in the Balance of Payments and the International Investment Position (Appendix VII).
- BoP and IIP treatment notes:
  - Inception: initial spot exchange recorded in “other investment” category of the financial account at agreed exchange rate.
  - Over the contract period, only margin payments and secondary market sales are recorded as transactions; valuation changes are generally treated as holding gains/losses and not recorded as BoP transactions, but valuation changes should be recorded in the IIP.
  - Illustrative Box A.1 and A.2 bookkeeping examples preserve exact amounts from example swaps (DC105 for FX100 reversing at DC110 for FX100) and show BoP and IIP recording and valuation movements at depreciation scenarios (e.g., domestic currency to DC140).

### Key stability considerations and policy implications (concluding insights)
- The 2007–2008 crisis illustrated how liquidity stress in international money markets can spill over into FX swap markets and affect macro-financial stability.
- Growing reliance on FX swaps for FX funding and increased cross-border use amplified concerns when the market faltered.
- Principal considerations:
  - Bank capital adequacy implications under the Basel Accords for capital charges on FX swap holdings.
  - Liquidity risk from margin calls even when FX swaps hedge FX exposure.
  - Accounting transparency under IAS 39 / IFRS increases on-balance-sheet recognition of derivatives.
  - Dislocations can increase funding and hedging costs, affect bank lending, and influence a country’s Balance of Payments.
  - FX swap transactions can exacerbate exchange rate volatility in illiquid or stressed markets with adverse real-sector effects.
- Policy implication:
  - Central banks and banks must ensure measures are in place to address stability problems arising from FX swap use; FX swaps are useful but not infallible and can exacerbate risks during turmoil.

*Source: _wp1055 (IMF Working Paper content provided in the input PDF).*

### References .............................................................................................................

### _wp1055 - References

### Introduction and Objectives
- The paper examines channels through which FX swap transactions could:
  - affect a country’s financial stability; and
  - impact economic stability.
- From a financial stability perspective, the paper:
  - shows how regulatory requirements under the Basel Accords affect the charge of banks holding FX swaps for funding and/or hedging purposes;
  - demonstrates how use of FX swaps by banks could have important implications for their liquidity positions, especially during periods of significant market volatility; and
  - discusses how recent accounting rules have improved the disclosure of FX swaps on banks’ balance sheets.
- From an economic stability perspective, the paper:
  - considers how dislocations in the FX swap market could increase the costs of funding and hedging for banks, with consequences for their lending activity and a country’s balance of payments;
  - discusses how FX swap transactions could cause significant exchange rate volatility during periods of market turmoil, with potential implications for economic activity; and
  - presents strategies that central banks could employ in mitigating pressures in the FX swap market.
- The paper is not intended as a critique of FX swaps; rather it discusses ways in which their use could have stability implications and how, while not an independent source of shock during the recent crisis, their widespread use may have amplified existing stresses.

*Key structural note*
- Background and key features of FX swaps are in Section II.
- Channels affecting financial stability are in Section III.
- Macro-economic implications are in Section IV.
- Central bank mitigation strategies are in Section V.
- Technical information and detailed applications are presented in the appendices.

### Stylized Facts and Market Developments
- Definition and functions:
  - An FX swap is an agreement between counterparties to exchange one currency for another, at predetermined times, without incurring foreign exchange risk; it represents borrowing and lending of currencies on a collateralized basis.
  - FX swaps are used for managing liquidity, shifting delivery dates, hedging FX positions, speculation, and taking positions on interest rates.
- Growth and turnover (pre-crisis trends):
  - Average daily turnover in traditional global FX markets expanded by 69 percent to $3.2 trillion over April 2004 to April 2007.
  - More than half the increase was attributable to FX swaps, with average daily turnover rising by 80 percent (versus 45 percent in the preceding three-year period).
  - Increase in FX swaps transactions between reporting dealers and other financial institutions accounted for about half the growth in global turnover.
  - Turnover with non-financial customers increased by 10 percent, accounting for 45 percent of all FX swap turnovers over 2004–07.
  - Share of FX swap transactions with maturity of less than seven days increased to 78 percent from 73 percent.
  - Cross-border transactions represented more than 60 percent of total FX swaps turnover in April 2007.
  - Cross-border turnover in FX swaps increased by 78 percent to $1.1 trillion between April 2004 and April 2007; about 35 percent of the increase was attributable to interbank transactions and almost 50 percent to transactions between reporting banks and non-bank financial institutions.
- Crisis-era contractions and volatility:
  - Positions in FX derivatives declined sharply in 2008 H2 among G-10 and Switzerland.
  - Notional amounts outstanding in forwards and FX swaps fell by 33 percent from the first-half of 2008, followed by an uptick of 9 percent in 2009 H1.
  - Forwards and FX swaps gross market values doubled to $1.6 trillion in 2008 H2, then almost halved to $870 billion in 2009 H1.
- Market scale and concentration:
  - FX swaps and spots represent the largest transactions traded in international FX markets.
  - FX transactions are estimated at around $4 trillion daily, with the top 10 currency traders accounting for nearly 80 percent of the total volume.

### Financial-Stability Channels and Regulatory Framework
- Risks highlighted:
  - FX activities can cause rapid large losses for banks, particularly under increased exchange-rate volatility.
  - Disruptions in the FX swap market can threaten banks’ solvency and liquidity and thereby the stability of the banking system.
- International standards and market practices that mitigate risks:
  - Basel Accords (Basel I and Basel II) are applied to capture risks posed by FX instruments.
  - International Financial Reporting Standards (IFRS) improve disclosure of FX swaps on banks’ balance sheets.
  - Market participants commonly use standardized International Swaps and Derivatives Association (ISDA) contracts, which include provisions for mitigating credit risk (e.g., collateral posting via credit support annex).
- Specific risk-mitigation mechanics in ISDA agreements:
  - The ISDA Master Agreement is a bilateral framework agreement that contains general terms and conditions and, together with Confirmations, governs individual derivatives transactions.
  - ISDA provisions mitigate credit risk by requiring the counterparty that is “out-of-the-money” to post collateral (usually cash, government securities or highly rated bonds) equal to the payable amount if all outstanding transactions were to be terminated.
  - Collateral other than cash is usually discounted for risk; the party posting collateral must do so in excess of the potential settlement amount.

### Market Dynamics Observed During the Recent Crisis
- Initial trigger and propagation:
  - Turbulence in FX swap markets in the second-half of 2007 and intensified in late 2008 was initially caused by a shortage of U.S. dollar funding among non-U.S. financial institutions.
  - Non-U.S. financial institutions sought U.S. dollars via FX swaps while traditional suppliers hoarded liquidity and withheld lending due to counterparty risk concerns, making the market increasingly one-sided.
  - As the crisis evolved, institutions with euro and Swiss franc liabilities also faced similar funding difficulties.
- Consequences:
  - One-sided order flow concentrated on U.S. dollar borrowing led to shifts away from covered interest parity for the euro, sterling and yen versus the U.S. dollar.
  - The premium international institutions paid for U.S. dollar funding became persistently large and positive during the crisis.
  - Hedging activity and speculative use of FX swaps increased volatility in FX spot markets for numerous currencies.
- Systemic implications:
  - Stress in the FX swap market raised concerns about banks’ ability to roll over funding, potentially constraining credit supply to local economies and affecting balance-of-payments financing.
  - The crisis highlighted the role of central banks in FX swap markets.

### Central Bank Role and Policy Responses (overview)
- Central banks emerged as important actors in FX swap markets during stress episodes, with strategies to mitigate pressures discussed in Section V.
- The paper presents considerations on how central bank FX swap operations impact their balance sheets (Box 5) and how central banks might intervene to alleviate dollar funding shortages and market dysfunctions.

### Appendices and Technical Material (content overview)
- Appendices provide technical and empirical material, including:
  - Developments in Global FX Swap Activity (Appendix I);
  - How FX Swaps Affect the Capital Adequacy Ratio (Appendix II);
  - Calculation of the Credit Risk Charge for FX Swaps (Appendix III);
  - Assumptions of FX Spot and Swap Rates (Appendix IV);
  - Closing a Net Open FX Position on the Balance Sheet Using FX Swaps (Appendix V);
  - An Illustration of How Margin Calls on FX Swaps are Calculated (Appendix VI);
  - Recording of FX Swaps in the Balance of Payments and the International Investment Position (Appendix VII).
- Illustrative tables and figures include:
  - Global FX turnover and FX swaps turnover by instrument, maturity, location, counterparty, and currency;
  - Notional amounts outstanding and gross market values of OTC foreign exchange derivatives;
  - Examples and step-by-step balance-sheet positions following FX swap transactions and spot operations;
  - Credit conversion factors, FX spot and swap rate assumptions, and examples of margin-call calculations.

*Source: _wp1055 - References (PDF chapter).*

### Box 1. Some Key Features of FX Swaps

### Box 1. Some Key Features of FX Swaps

### Basic mechanics and definitions
- An FX swap is a standard instrument traded in the over-the-counter (OTC) market.  
- An FX swap has two separate legs settling on two different dates; it provides for one exchange and one re-exchange only (and is not a stream of payments). One currency is swapped for another for a period of time, and then swapped back.  
- Deal date (also referred to as the contract date) is when counterparties enter into the FX swap contract. Value dates are the dates on which the currencies are exchanged and re-exchanged.  
- Counterparties agree to exchange two currencies at a particular rate on one value date (the “near date” or the “spot value date”) and to reverse payments, almost always at a different rate, on a specified subsequent value date (the “far date”).  
- If both value dates are less than one month from the deal date, it is known as a “short-dated swap”; if one or both value dates are one month or more from the deal date, it is a “forward swap.” The two legs can, in principle, be attached to any pair of value dates.

### Market conventions and maturities
- In practice, a limited number of standard maturities account for most FX swap transactions.  
- The first leg usually occurs on the spot value date, and for about three-quarters of all FX swaps the second leg occurs within a week; however, there are also FX swaps with longer maturities of up to several years.  
- Among dealers, most are arranged for even or straight dates—e.g., one week, one month, three months—but odd or broken dates are also traded for customers.

### Pricing and swap points
- The cost of an FX swap is determined by the interest rate differential between the two swapped currencies.  
- Arbitrage and the principle of covered interest rate parity operate to make the cost of an FX swap equal to the FX value of the interest rate differential between the two currencies for the period of the swap (instances of deviations from covered interest parity are discussed elsewhere in the source).  
- The cost of the FX swap transaction is measured in swap points. Consequence described in the source: when DC r rises, the swap points for borrowing domestic currency increases. The counterparty that holds the currency that pays the higher interest rate for the period of the swap will pay the points, neutralizing the interest rate differential and equalizing the return on the two currencies, while the counterparty that holds the currency that pays the lower interest will earn or receive the points.  
- At the outset of the transaction, the present value of the FX swap contract is always zero (excluding the transaction cost).

### Uses and distinctions from related instruments
- FX swaps are used to hedge FX exposures and to fund foreign exchange balances; the FX swap market tends to be much more liquid than the forward market.  
- The FX swap differs from the interest rate swap (exchange of a stream of interest payments in the same currency with no exchange of principal) and from the currency swap (exchange and re-exchange of principal and streams of fixed or floating interest payments in two different currencies).

### Capital charges under the Basel Accords
- A bank’s capital adequacy ratio is derived from regulatory capital and risk-weighted assets. Under the Basel Accords, risk weights are applied to assets on a bank’s balance sheet (risk-weighted assets) to calculate capital charges and determine adequate capitalization.  
- The use of FX swaps by banks would incur a capital charge for credit risk, but reduce the capital requirements for market risk.  
- Credit risk: Under the Basel Accord, a “credit exposure” for derivatives such as swaps, forwards and options on currency, interest rate, equity and commodity products would be calculated as the sum of the current net replacement value (NRV) plus an add-on component that captures future exposure, depending on the tenor and type of contract. Counterparty risk weights are then applied to the credit exposure to derive the credit risk charge.  
- Market risk: There is a capital charge for FX risk under Pillar I on Minimum Capital Requirements, so that banks which hold overall net open FX positions on their balance sheets will be subject to a capital charge of 8 percent of the overall net open positions. Thus, banks have significant incentive to close such exposures through hedge transactions, commonly using FX swaps. In other words, banks’ use of FX swaps for hedging purposes, despite incurring credit risk, could help to reduce capital charges for market risk.

### Liquidity risk and margining
- Use of FX swaps could increase liquidity risk for banks. A bank that is perfectly hedged in terms of FX exposure would still be exposed to liquidity movements arising from that hedge due to marking-to-market under ISDA agreements and the resulting need for more frequent collateral payments via margin calls. Variations in fair value of an FX swap could potentially drain a bank’s liquidity in volatile market conditions.  
- Margin calls by a swap counterparty may be triggered by a sharp depreciation of the domestic currency resulting in a large fair value adjustment (FVA). Persistent weakening of the spot domestic currency exchange rate could lead to continued margin calls and sustained outflows of liquidity, potentially producing solvency problems if the bank cannot meet short-term cash flow obligations.

### Margin calls on FX swap contracts (summary of Box 2)
- FX swaps are bilateral OTC contracts and create counterparty risk; centrally cleared markets mitigate this risk via a clearinghouse, initial collateral, and maintenance margin requirements.  
- In OTC markets, counterparties may trade up to an agreed margin threshold; a margin call is made when exposure exceeds this threshold. Margin thresholds are mutually agreed, determined on a counterparty-by-counterparty basis, and typically based on credit ratings. FX swaps are typically conducted under negotiated master swap agreements (such as ISDA) that include exposure threshold mechanisms allowing collateralization beyond a certain level.  
- A margin call occurs when a position is “in the money” for one party and “out of the money” for the other. The out-of-the-money party must post collateral (cash or securities) to cover credit risk. The collateral amount is calculated as the difference between the contracted forward exchange rate payable at maturity and the forward exchange rate on the mark-to-market day, discounted using the market-determined interest rate to arrive at net present value, and less the margin threshold.  
- Swap exposures cannot be netted across counterparties (although netting within the same counterparty is possible). This prevents offsetting margin calls across counterparties and may tie up a bank’s working capital even if its net market exposure across counterparties is zero, creating a drain on liquidity.

### Accounting and transparency under IFRS (IAS 39)
- IAS 39 is the main standard for derivatives and prescribes principles for recognizing and measuring financial assets, financial liabilities and contracts for non-financial items, including financial derivatives. IAS 39.9 defines a derivative as a financial instrument that derives its value from an underlying price or index; derivatives are categorized as: (i) forward (futures) contract; (ii) swap; and (iii) option.  
- IAS 39 brings derivatives onto the financial statements, increasing transparency. All derivative instruments must be carried at fair value on the balance sheet, for example, through marking-to-market. Any change in fair value should be recognized in the profit and loss statement (and ultimately retained earnings), i.e., by making an FVA. Gains and losses from a hedging instrument cannot be offset against gains and losses in the value of the hedged item.  
- FX swaps are carried on the balance sheet at fair value. On the day transacted, fair value is likely to be zero. On a balance sheet date, the swap value may be positive (asset), negative (liability) or zero. The main factor causing fair value to vary from zero is movement in the forward rate relative to the contracted forward exchange rate. Upon settlement the swap is closed out at transaction value and drops out of mark-to-market.

### Economic stability and FX swap market stress
- A well-functioning FX swap market supports macroeconomic and external stability by allocating FX liquidity efficiently and reducing spot exchange rate volatility. During periods of financial stress, spillovers to the FX swap market can cause illiquidity and significantly increase transaction costs, potentially creating an external financing gap and pressure on a country’s currency. Central banks may provide FX swap facilities to market participants to mitigate effects of financial stress.  
- Increased costs of FX funding and hedging: High reliance on funding through FX swaps can result in severe liquidity shortages during turbulent periods and a rise in funding costs. During the recent crisis, U.S. dollar funding became scarce, making it increasingly costly to obtain U.S. dollars through FX swaps with the euro, the pound sterling and the Japanese yen. Prior to August 2007, the U.S. dollar “basis” was close to zero; in late-2007 the spread widened, implying a market-based U.S. dollar funding rate higher than U.S. dollar LIBOR. Counterparties became reluctant to lend FX over longer periods, leading to a sharp shortening of FX swap maturities and increasingly costly rollover activity.  
- Channels through which more costly FX swaps impair macroeconomic stability:  
  - Hedging existing balance sheet positions becomes more expensive; inability to hedge leads to regulatory capital charges or balance sheet shrinking, which can translate into a liquidity squeeze in the domestic economy.  
  - Obtaining FX funding becomes more expensive, potentially increasing the cost of credit to the economy.  
  - Increased perceived counterparty risk may require lower margin thresholds; subsequent margin calls would reduce liquid assets available to banks that are out-of-the-money, further reducing their ability to provide credit to the economy.

*Source: IMF working paper content provided in the input PDF.*

### Box 3. The Pricing of an FX Swap

### Box 3. The Pricing of an FX Swap

### Pricing concept and no-arbitrage condition
- Example setup: European investor with horizon of 3 months (three months).
- Two investment options:
  - (i) Invest in the unsecured euro cash market for three months at the prevailing euro-denominated interest rate.
  - (ii) Convert euro into U.S. dollars through a three-month FX swap and invest dollars for three months at the prevailing dollar-denominated interest rate (example: purchasing and holding a three-month U.S. Treasury bill), then conclude the FX swap after three months by trading dollars back for euro.
- Efficient market implication: the two strategies must provide equal returns at the end of three months; otherwise arbitrage would equalize returns.
- Definition: U.S. dollar “basis spread” on another currency = the premium paid by international institutions to obtain dollars in the FX swap market.
- Basis spread formula (text):
  - U.S. dollar basis spread on the euro = Implied FX swap U.S. dollar interest rate – benchmark U.S. dollar interest rate.
- Practical derivation: using data on euro-dollar spot and forward rates, and euro LIBOR as proxy for European interest rate, one can derive the U.S. dollar interest rate implied by euro-dollar FX swaps; the basis is the difference between this implied rate and a benchmark unsecured U.S. dollar lending rate such as U.S. dollar LIBOR.
- Typical behavior: during normal times, the U.S. dollar basis spread on another currency should hover around zero for the major, very liquid currencies.
- Crisis behavior: during the recent global financial crisis, FX swap-implied U.S. dollar funding rates significantly exceeded the dollar-denominated interest rate on several occasions, when demand for the U.S. dollar far outstripped its supply.

### Empirical indicators (as presented)
- Figures (described): U.S. dollar interest rate implied by USD/EUR, USD/GBP, USD/JPY 3-month FX swaps; U.S. dollar LIBOR rate; U.S. dollar basis spread (RHS). Data sources: Bloomberg; and authors’ calculations.

### Channels from FX swap market dislocations to external financing gaps
- Mechanisms by which a dysfunctional FX swap market can create a Balance of Payments (BoP) external financing gap:
  - Shortening of maturities from concerns about counterparty risk front-loads rollover requirements; combined with higher FX swap costs, this increases external financing needs and may force institutions to close out FX swap positions and repay FX obligations, creating spot FX demand and pressure on the domestic currency.
  - Foreign counterparties constrained for liquidity or concerned about counterparty risk may cut exposures to FX swaps, reducing external financing available to the country and increasing the external financing gap.
  - Margin calls on FX swap contracts with foreign counterparties generate financial account outflows; aggregate outflows can be substantial since margin calls are typically linked to factors such as exchange rate depreciation that may affect many domestic institutions simultaneously.
- Macroeconomic consequences of closing an external financing gap:
  - Pressure on the exchange rate or central bank international reserves (depending on exchange rate regime).
  - Squeeze in FX liquidity in the domestic economy, affecting trade and other economic activity.

### How hedging and speculation via FX swaps can affect the spot exchange rate (Box 4 scenarios)
- General point: in times of market stress, when markets are illiquid or one-sided, FX swap transactions can exacerbate exchange rate volatility via hedging or speculative flows.
- Scenario 1 — Bank closing a net open FX position:
  1. A local bank with excess FX-denominated assets (long FX position) converts excess domestic currency liquidity to FX via an FX swap.
  2. The bank sells the FX in the spot market for domestic currency, potentially strengthening the domestic currency.
  3. At swap maturity the bank sells domestic currency for FX in the spot market to repay the FX, potentially weakening the domestic currency.
- Scenario 2 — Foreign investor holding local securities:
  1. Foreign investor enters into an FX swap to borrow domestic currency and lend FX (taking on a domestic currency-denominated liability and an FX-denominated asset).
  2. The investor sells domestic currency on the spot market for FX, potentially weakening the domestic currency.
  3. When selling local securities later, receipt in domestic currency is swapped back for FX.
- Scenario 3 — Speculator in the FX market:
  1. Speculator swaps FX for domestic currency (borrows domestic currency and lends FX) with a bank.
  2. Speculator sells domestic currency on the spot market for FX, contributing to weakening of domestic currency.
  3. At swap maturity the speculator purchases domestic currency on the spot market (anticipating a significantly depreciated level) and swaps it back for FX with the bank.
- Note: Speculators improve liquidity and play a role in risk repricing; while they may increase volatility at times, they also support market functioning in liquid markets.

### Central bank measures to mitigate FX swap market risks and shocks
- FX swap facilities are standard central bank liquidity-management instruments; uses include controlling system liquidity, managing international reserves, and smoothing disorderly exchange rate fluctuations.
- Central bank policy options in response to FX funding shortages and exchange rate pressure:
  - Raise interest rates to attract investors.
  - Intervene via outright sales of foreign reserves to meet funding needs and alleviate exchange rate pressure.
  - Use existing foreign exchange reserves for FX swap operations with market counterparties.
- Balance sheet implications:
  - Provision of FX liquidity through FX swaps can result in temporary or permanent drawdown of liquid FX assets.
  - Reduction in FX assets is typically offset by an increase in FX assets receivable in the future (a claim on the counterparty at swap settlement).
  - Given covered nature of FX swaps, central banks normally do not assume underlying FX risk; however, drawdown could be permanent if the swap counterparty defaults.
  - By contrast, FX spot sales permanently draw down reserves.
- Crisis usage and coordination:
  - During the recent crisis central banks used FX swap facilities extensively to increase FX liquidity when domestic institutions faced FX funding shortages.
  - Swap lines between central banks were established to backstop limited liquid reserves in shortage currencies.
  - Major central banks coordinated actions; the U.S. Federal Reserve and the European Central Bank opened swap lines with each other and with various other countries amid substantial dollar and euro shortages in December 2007 and at various points in 2008. These swap lines augmented liquid euro and U.S. dollar assets of receiving central banks, enabling them to provide large amounts of FX to domestic market participants through their own FX swap facilities.

### Balance sheet mechanics of a central bank FX swap operation (Box 5 example)
- Operation example parameters:
  - Central bank provides FX100 million, equivalent to DC105 million at current spot rate.
  - Priced at 5 forward basis points (or 500 pips) premium (i.e., the forward rate is 1.05 + 0.05 = DC1.10 per unit of FX).
  - At start: central bank provides FX100 million to the market and absorbs DC105 million.
  - On maturity: central bank removes FX100 million and injects DC110 million back into the market.
- Balance sheet effects (as presented):
  - Spot leg transaction (providing FX and absorbing domestic currency):
    - Assets: Net foreign assets －FX100 million
    - Liabilities: Currency in circulation; Net domestic assets Bank reserves －DC105 million
    - Monetary base = Monitory base －FX 100 million; Monetary base －DC105 million (as shown in source table layout)
  - Forward leg transaction (forward asset and liability created):
    - Assets: Net foreign assets ＋FX100 million
    - Liabilities: Currency in circulation; Net domestic assets Bank reserves ＋DC110 million
    - Monetary base = Monetary base ＋FX100 million; Monetary base ＋DC110 million (as shown in source table layout)
- Accounting treatment:
  - FX swaps create contingent assets and liabilities; they are typically treated as off-balance sheet items initially and subsequently recorded on-balance sheet as receipts or payments occur.
  - The structure of FX swaps, with forward leg terms set in advance, ensures these operations do not carry exchange rate or other market risks in normal conditions, although large notional short positions could create FX vulnerabilities and counterparty default could affect composition of foreign and domestic currency in the balance sheet.
- Data and reporting:
  - The data template on International Reserves and Foreign Currency Liquidity supplements traditional reserve data with foreign currency positions and off-balance sheet activities; it is a prescribed category of the IMF’s Special Data Dissemination Standard.

### Concluding insights and policy implications
- The 2007–2008 crisis highlighted how liquidity stress in international money markets can spill over into FX swap markets and affect macro-financial stability.
- Growing reliance on FX swaps for FX funding and increased cross-border use amplified concerns when the market faltered.
- Key stability considerations:
  - Bank capital adequacy (Basel Accords) implications for capital charges on FX swap holdings (speculation, funding, hedging).
  - Liquidity risk from margin calls even when FX swaps are hedged for FX movements.
  - Accounting transparency improvements under IFRS bring many FX swap positions onto balance sheets.
  - Dislocations can increase funding and hedging costs, affect bank lending, and influence a country’s Balance of Payments.
  - FX swap transactions can exacerbate exchange rate volatility in illiquid or stressed markets with adverse real-sector effects.
- Central banks and banks must ensure measures are in place to address stability problems arising from FX swap use; FX swaps are useful but not infallible and can exacerbate risks during turmoil.

*Source: Box 3. The Pricing of an FX Swap (extracted content).*

### APPENDIX I. DEVELOPMENTS IN GLOBAL FX SWAP ACTIVITY

### APPENDIX I. DEVELOPMENTS IN GLOBAL FX SWAP ACTIVITY

### Global turnover and major centers
- FX swap activity in advanced countries and major financial centers dominated global activity.
- By April 2007:
  - The United Kingdom—the global center for FX—had recorded the biggest turnover, averaging almost $900 billion daily.
  - The United States was the next largest, at almost $240 billion daily.
  - Among advanced countries, Slovenia had the least active FX swap market, with an average daily turnover of only $60 million.
- Turnover among emerging market countries in April 2007 varied markedly:
  - From $32 million in Brazil to $15 billion in Russia.

### Share of emerging market currencies and instrument use
- The share of emerging market currencies in FX activity increased:
  - These currencies were used in almost 20 percent of all transactions in 2007, compared to about 15 percent in 2004 (BIS, 2007).
- Instrument composition by currency:
  - FX spot and forward transactions tended to be dominated by emerging market currencies.
  - FX swaps were particularly popular for currencies of major financial centers (e.g., Hong Kong and Singapore), in countries with greater reliance on market funding (e.g., Australia, New Zealand), and in important host banking countries (e.g., Denmark, Sweden).

### Growth in positions (2004–07) and drivers
- Positions in forwards and FX swaps expanded strongly over 2004–07:
  - Outstanding notional amounts increased by 78 percent over 2004–07, compared to 26 percent in the preceding 3-year period.
  - The expansion was largely driven by non-financial customers:
    - Outstanding positions of non-financial customers more than doubled during 2004–07, compared to a 33 percent rise between 2001 and 2004.
  - Gross market value increased by 45 percent over 2004–07, following three previous periods of declines.
- The increases in notional and gross market values were predominantly driven by transactions between reporting dealers and other parties.

### Impact of the 2008–09 financial crisis on FX swap activity
- FX derivative positions fell sharply in H2 2008.
- Among the countries comprising the G-10 and Switzerland:
  - Notional amounts outstanding in forwards and FX swaps fell by 33 percent in H2 2008, followed by a 9 percent uptick in H1 2009.
- Market participant and turnover changes:
  - The average daily volume in FX swaps at U.S.-based market participants fell by 27 percent in April 2009 compared to a year earlier.
  - On a counterparty basis, the average daily volume between surveyed U.S. participants and non-financial customers fell by almost 58 percent over the April 2008–09 period.
  - Activity by maturity fell across the board.
  - In the United Kingdom, turnover in FX swaps fell by almost 29 percent during April 2008 to April 2009:
    - Activity between surveyed institutions and non-financial institutions fell the most, by 41 percent.
    - Activity with all other financial institutions declined by 28 percent.

### Market concentration
- Overall market concentration in OTC FX derivatives increased over time.
- The Herfindahl index (defined as the sum of the squares of the market shares of each individual institution; it ranges from 0 to 10,000) shows that increases in market shares of individual reporting institutions were more pronounced in:
  - Forwards, FX swaps and currency swaps markets, compared to the options market.

*Source: Bank for International Settlements data and related analysis presented in APPENDIX I. DEVELOPMENTS IN GLOBAL FX SWAP ACTIVITY.*

### 3. At this point, any depreciation (appreciation) in the domestic currency spot

### _wp1055 - 3. At this point, any depreciation (appreciation) in the domestic currency spot

### Balance-sheet impact of spot depreciation/appreciation
- A movement in the spot exchange rate to DC1.40 per unit of FX at the maturity of the swap contract has symmetric effects on the asset and liability sides of the balance sheet and on profit and loss.
- Accounting entries showing equal and offsetting FX loss and gain of DC35 million:
  - DR Loss on FX transaction DC35 million; CR FX Swap payable DC35 million
  - DR FX Receivables DC35 million; CR Gain on FX transaction DC35 million
- Outcome: no net impact on the balance sheet when the bank holds a closed position (Figure A.14).
- Balance sheet snapshot (In millions of DC) after depreciation with closed position:
  - Assets total DC360; Liabilities + Equity total DC360
  - Asset entries include DC Cash 170, DC Other 50, FX Receivables 140
  - Liability/Equity entries include DC Various 305, DC Capital 55

### Settlement of FX swap contract by purchasing FX in spot market (maturity)
- FX purchased at spot rate DC1.40 per unit of FX with accounting entries:
  - DR FX Cash DC140 million; CR DC Cash DC140 million
- Discount on the swap amortized:
  - DR DC Deferred discount DC5 million; CR DC Discount account DC5 million
- Swap contract repaid:
  - DR FX Swap payable DC140 million; CR FX Cash DC140 million
- Swap receivable settled:
  - DR DC Cash DC110 million; CR DC Swap receivable DC110 million
- Outcome: the bank returns to an open FX position and would need to roll over the swap to close the position again (Figure A.15).
- Balance sheet snapshot (In millions of DC) following settlement with purchase of FX in spot market:
  - Assets total DC360; Liabilities + Equity total DC360
  - Asset entries include DC Cash 170, DC Other 50, FX Receivables 140
  - Liability/Equity entries include DC Various 305, DC Capital 55

### Alternative settlement: using maturing FX receivables to repay swap
- If FX Receivables mature simultaneously with the swap, receipts can be used directly to repay the contract.
- Discount on the swap amortized:
  - DR DC Deferred discount DC5 million; CR DC Discount account DC5 million
- Receipt of FX receivables paid out to swap counterparty:
  - DR FX Cash DC140 million; CR FX Receivables DC140 million
- Swap contract repaid:
  - DR FX Swap payable DC140 million; CR FX Cash DC140 million
- Swap receivable settled:
  - DR DC Cash DC110 million; CR DC Swap receivable DC110 million
- Outcome: removes the FX asset from the balance sheet so that only domestic currency positions remain (Figure A.16).
- Balance sheet snapshot (In millions of DC) following settlement with maturing assets:
  - Assets total DC360; Liabilities + Equity total DC360
  - Asset entries include DC Cash 310, DC Other 50
  - Liability/Equity entries include DC Various 305, DC Capital 55

### Synthetic forward replication
- The balance sheet position after the swap is essentially a replication of an outright forward contract—a “synthetic forward” position.
- Example outright forward: bank undertakes to pay out FX100 at maturity in exchange for domestic currency at agreed forward rate DC1.10 per unit of FX.
- Accounting entries for the forward transaction:
  - DR DC Forward receivable DC110 million
  - CR FX Forward payable DC105 million (= FX100 million)
  - CR DC Deferred discount DC5 million
- Balance sheet snapshot (In millions of DC) following forward transaction (Figure A.17):
  - Assets total DC465; Liabilities + Equity total DC465
  - Asset entries include DC Cash 200, DC Other 50, FX Receivables 105, DC Forward receivable 110, DC Deferred discount 5
  - Liability/Equity entries include DC Various 305, FX Forward payable 105, DC Capital 50

### Illustration of margin calls on FX swaps (Appendix VI)
- Transaction setup:
  - Contract at t0: bank provides DC105 million in exchange for FX100 million.
  - Maturity t12: bank repays FX100 million and receives DC110 million (swap rate DC1.10 per unit of FX).
  - Margin thresholds: bank DC5 million; counterparty FX7 million.
  - Positions marked-to-market monthly; collateral called depending on who is in-the-money/out-of-the-money.
- Key dated movements and margin consequences (intervening 12 months):
  1. Between t0 and t3 the domestic currency swap rate initially appreciates against FX; bank is “in the money”, counterparty “out of the money”.
  2. At t2 swap rate DC1.00 per unit of FX: counterparty out-of-the-money exceeds FX7 million threshold by FX3 million → margin call of FX3 million by bank.
  3. At t3 swap rate DC0.98 per unit of FX: counterparty out-of-the-money exceeds FX7 million threshold by total FX5.2 million → additional margin call of FX2.2 million (having already called FX3 million).
  4. At t4 swap rate DC1.03 per unit of FX: counterparty out-of-the-money by FX6.8 million, which is less than FX7 million threshold → bank repays counterparty total margin previously called of FX5.2 million.
  5. At t6 swap rate DC1.15 per unit of FX: bank out-of-the-money by DC5 million, equal to bank’s DC5 million threshold → no margin call.
  6. At t7 swap rate DC1.19 per unit of FX: bank out-of-the-money by DC9 million, DC4 million above threshold → counterparty calls DC4 million.
  7. At t8 swap rate DC1.25 per unit of FX: bank out-of-the-money by DC15 million → additional margin call of DC11 million by counterparty.
  8. At t12 maturity swap rate DC1.45 per unit of FX: bank out-of-the-money by DC35 million, and margin calls totaling DC30 million (DC35 million less the margin threshold of DC5 million) would have been paid to the counterparty.
- Note on valuation: amounts would typically be discounted by the market-determined interest rate; for this illustration discounting is assumed negligible.

*IMF Working Paper content unit: _wp1055 - 3. At this point, any depreciation (appreciation) in the domestic currency spot*

### 9. At this point, if the bank fulfils its swap contract and repays the counterparty FX100

### 9. At this point, if the bank fulfils its swap contract and repays the counterparty FX100 million in exchange for DC110 million, counterparty risk is extinguished

### Margin calls, settlement, and liquidity implications
- If the bank fulfils its swap contract and repays the counterparty FX100 million in exchange for DC110 million, counterparty risk is extinguished.
- The total margin called of DC30 million and held by the counterparty in an escrow account is returned to the bank.
- If the bank may not have sufficient liquidity to meet margin calls before the contract expires, its liquidity problem may well become a solvency problem.

### Differences between accounting entries and valuation
- Accounting entries: for financial reporting purposes—note or disclose the position on the balance sheet.
- Establishing valuation at any point other than as part of the financial cycle: normally done for efficiency/trading or for credit collateral purposes.
- Implication: marking to market or valuation outside the normal financial cycle serves different objectives than standard accounting disclosure.

### Example: Calculation of Margin Calls on FX Swaps (Table A.3) — key figures (In millions of domestic currency units)
- Time series (n=0 to n=12) shows Spot Rate (DC per unit of FX), FX, DC, Marked-to-Market Liability, In/(Out) of the Money, Margin Threshold, Excess of Margin, Margin Call.
- Selected data points (preserve exact values as in table):
  - n=0: Spot Rate 1.05, FX 1.00, DC 1.10, Marked-to-Market 110, In/(Out) 0, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=1: Spot Rate 1.03, FX 1.00, DC 1.05, Marked-to-Market 105, In/(Out) 5, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=2: Spot Rate 1.01, FX 1.00, DC 1.00, Marked-to-Market 100, In/(Out) 10, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=3: Spot Rate 0.99, FX 1.00, DC 0.98, Marked-to-Market 98, In/(Out) 12, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=4: Spot Rate 1.02, FX 1.00, DC 1.03, Marked-to-Market 103, In/(Out) 7, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=5: Spot Rate 1.08, FX 1.00, DC 1.10, Marked-to-Market 110, In/(Out) 0, Margin Threshold 5, Excess of Margin 0, Margin Call 0
  - n=6: Spot Rate 1.12, FX 1.00, DC 1.15, Marked-to-Market 115, In/(Out) (5), Margin Threshold 50, Excess of Margin 0
  - n=7: Spot Rate 1.16, FX 1.00, DC 1.19, Marked-to-Market 119, In/(Out) (9), Margin Threshold 54, Excess of Margin 4
  - n=8: Spot Rate 1.20, FX 1.00, DC 1.25, Marked-to-Market 125, In/(Out) (15), Margin Threshold 51, Excess of Margin 0   6
  - n=9: Spot Rate 1.25, FX 1.00, DC 1.31, Marked-to-Market 131, In/(Out) (21), Margin Threshold 51, Excess of Margin 6   6
  - n=10: Spot Rate 1.32, FX 1.00, DC 1.35, Marked-to-Market 135, In/(Out) (25), Margin Threshold 52, Excess of Margin 0   4
  - n=11: Spot Rate 1.38, FX 1.00, DC 1.42, Marked-to-Market 142, In/(Out) (32), Margin Threshold 52, Excess of Margin 7   7
  - n=12: Spot Rate 1.40, FX 1.00, DC 1.45, Marked-to-Market 145, In/(Out) (35), Margin Threshold 53, Excess of Margin 0   3
- Total margin called reported in the table: 30

(Note: table includes a second representation with related figures such as Marked-to-Market expressed per 100 FX units and corresponding margin thresholds; selected rows:)
- Second panel sample rows:
  - n=0: Spot Rate 1.05, FX 1.00, DC 1.10, (9) = (3)t0/(3)tn * (2)tn = 100.0, (10)=100–(9)=0.0, (11)=7, (12)=0.0, (13)=0.0
  - n=1: Spot Rate 1.03, FX 1.00, DC 1.05, (9)=104.8, (10)= (4.8), (11)=70, (12)=.0 0, (13)=.0
  - n=2: Spot Rate 1.01, FX 1.00, DC 1.00, (9)=110.0, (10)= (10.0), (11)=73, (12)=.0 3, (13)=.0
  - n=3: Spot Rate 0.99, FX 1.00, DC 0.98, (9)=112.2, (10)= (12.2), (11)=75, (12)=.2 2, (13)=.2
  - n=4: Spot Rate 1.02, FX 1.00, DC 1.03, (9)=106.8, (10)= (6.8), (11)=7, (12)=0.0, (13)=-5.2
  - n=12: (Closing) (9)=75.9, (10)=24.1, (11)=7, (12)=0.0, (13)=0.0
- Second panel total: 0.0

### Balance of Payments (BoP) treatment of FX swaps — key points
- BoP records transactions between residents and non-residents; an FX swap is recorded in the BoP and the IIP if it is a contract between residents and non-residents.
- Creation of an FX swap contract does not generally involve a transaction in financial derivatives in the financial account, although the underlying flows of currencies should be recorded as transactions in the BoP.
- At inception: a spot exchange of currencies and a simultaneous commitment to transact in the future at agreed prices; initial exchange recorded in “other investment” category of the financial account at the exchange rate agreed by the counterparties.
- Commissions or fees (e.g., to banks, brokers, dealers) are classified as payments for services in the current account and should be deducted from the value of the financial derivative.
- Over the contract period, only transactions related to margin payments and sales in secondary markets should be recorded in the BoP.
- Changes in value of an FX swap due to exchange rate movements during the contract period are generally treated as holding gains or losses, which is not recorded as a transaction in the BoP.
- Transactions recorded over the contract period only in the following cases:
  - Margin payments and receipts: a margin payment is recorded as a reduction in financial derivative liabilities only if it is non-repayable; the receipt of non-repayable margin is recorded as a reduction in financial derivative (probably currency and deposits).
  - Secondary market transactions: sales of FX swap contracts in secondary markets are valued at market prices and recorded in the financial account as a transaction in financial derivatives.
- Settlement: at settlement, the difference between the values of the currencies exchanged is allocated to a transaction in a financial derivative; increase/decrease entries described depending on whether value received exceeds value paid.

### International Investment Position (IIP) treatment of FX swaps — key points
- IIP represents assets and liabilities vis-à-vis the outside world at a reference date; FX swaps are valued at current market prices on appropriate reference dates.
- Recommended compilation: data on gross assets and gross liabilities by summing the values of individual contracts in asset and liability positions.
- Variations in positions attributed to transactions and valuation changes:
  - Transactions: recording in IIP consistent with financial accounts of BoP.
  - Valuations: changes in market value due to price and exchange rate changes should be accounted for in the IIP even if they do not give rise to a transaction.
- Therefore, at any reference date over the contract period, valuation changes due to exchange rate changes should be recorded in the IIP in addition to BoP transactions.

### Illustrative bookkeeping examples (Boxes A.1 and A.2) — exact figures preserved
- Box A.1 (BoP example):
  - Assume domestic bank swaps DC105 for FX100, with reverse 12 months later at forward price DC110 to FX100.
  - At inception recorded in financial account:
    - Debit Other investment, currency and deposits 100
    - Credit Portfolio investment — Financial derivatives 100
  - After 12 months, domestic currency depreciated to DC140 against foreign currency. The amount of FX21 (=DC30/1.40) represents the equivalent loss in domestic currency; balance of FX79 (DC110/1.40) is equivalent amount that would have been paid if domestic currency had not depreciated.
  - At settlement recorded in financial account:
    - Debit Portfolio investment — Financial derivatives 21
    - Debit Other investment, currency and deposits 79
    - Credit (counterpart) 100
- Box A.2 (IIP example):
  - Same initial swap: DC105 for FX100, reverse at DC110 for FX100.
  - Opening position: Other investment, currency and deposits 100; financial derivatives 0.
  - After six months (end-March), domestic currency depreciated to 112: valuation change in IIP recorded as Portfolio investment — Financial derivatives: -6 (valuation); Other investment unchanged at 100.
  - After 12 months, domestic currency depreciated to DC140: IIP changes show Portfolio investment — Financial derivatives: -6 (opening valuation) +21 (transaction) -15 (valuation) = 0; Other investment, currency and deposits: 100 -21 +79.

*Source: Authors’ calculations.*

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